- This paper explores why theories about the effects of intellectual property rights (IPR) protection on foreign direct investment (FDI) and innovation have reached mixed conclusions. In our model, Northern firms innovate to improve the quality of existing products and may later shift production to the South through FDI. Southern firms may then imitate the products of multinationals. We find that imitation can increase FDI and innovation for quality improvements, whereas the opposite occurs when innovators develop new varieties. Hence, stronger IPR protection, by reducing imitation, may shift innovation away from improvements in existing products toward development of new products. 2006 Elsevier B.V. All rights reserved.